The Tax Foundation is the nation’s leading independent tax policy nonprofit. Since 1937, our principled research, insightful analysis, and engaged experts have informed smarter tax policy at the federal, state, and global levels. For over 80 years, our goal has remained the same: to improve lives through tax policies that lead to greater economic growth and opportunity.

Gasoline Taxes: User Fees or Pigouvian Levies?

(The following article originally appeared in the November 27, 2006 edition of Tax Notes.)

Americans disdain taxes generally, but certain levies have been more widely accepted than others. Gasoline taxes have generally enjoyed public support when used to fund and maintain America’s roadways. Alterative justifications for gasoline taxes are increasingly popular among some academics, but they have yet to resonate with the American public.

For nearly a century, gasoline taxes have played a central role in financing roadways with tax dollars collected from motorists. Today, the federal gas tax rate is 18.4 cents per gallon purchased. In addition, every U.S. state and many municipal governments levy some form of gas tax. As a result, the combined burden of local, state and federal gas taxes costs American drivers nearly 50 cents per gallon on average.1

Gasoline Taxes and the Benefit Principle The basic justification for gasoline excise taxes is what economists call the benefit principle of taxation. Simply stated, consumers of government services should pay in proportion to the benefit they obtain from those services. The benefit principle is a longstanding cornerstone of the theory of tax justice, which dates back to at least Adam Smith’s Wealth of Nations. It is also widely accepted in modern public finance theory as representing sound tax policy.

Gasoline usage has historically served as a proxy for damage done to public roads. It makes little sense to take income tax payments from elderly retirees to pay for roads they will never use. Consequently, government levies on gasoline have been used to raise funds that were depleted by road-related expenses.

If the revenue from motorists’ gasoline taxes is directed to exclusively pay for the roads they use, gasoline taxes can serve as a pure “user fee” and the benefit principle is met. When taxes are levied in direct proportion to the benefit the taxpayer receives, economists say this is an efficient distribution of a public good.

When gasoline taxes follow the benefit principle of taxation, economists view gasoline taxes as one of the best forms of taxation. In some respects, solely relying on the benefit principle of taxation will yield an outcome that parallels the market pricing of private goods.2

If gasoline taxes are to meet the criteria of the benefit principle, gasoline tax revenue must be spent exclusively on building and maintaining roads. With the exception of funds directed towards the Leaking Underground Storage Tank Fund, gasoline tax revenues are directed almost exclusively into the Highway Trust Fund. However, this does not ensure these funds are used properly for roads.

For instance, over 15 percent of gasoline tax revenue in the Highway Trust Fund is specifically diverted away from road maintenance and directed towards mass transit purposes. Some argue that mass transit should be subsidized because a successful mass transit system removes traffic from roadways. While that might be true at the margin, research indicates government subsidization of mass transit programs is a highly inefficient use of taxpayer dollars.3 While government investment in mass transit may be a questionable use of Highway Trust Fund finances, it is more worthy of trust fund spending than numerous programs that aren’t even related to transportation.

The astronomical growth in the practice of using highway funds to pay for politically motivated projects is one of the most disconcerting examples of improper use of highway funds. Some experts estimate that total diversions of gasoline tax dollars away from legitimate general road use equal nearly 40 percent of the Highway Trust Fund’s annual budget.4

The Federal Aid Highway Act of 1968 included the first recorded specifically earmarked highway project, funded through the highway trust fund.5 The popularity of earmarking projects grew so much that President Ronald Reagan vetoed the 1987 transportation bill because of the largesse of its 152 demonstration projects.6

The most recent highway bill, SAFETEA-LU, was passed by large majorities in Congress and signed by President Bush on August 10, 2005. SAFETEA-LU authorized $286.5 billion for transportation programs from fiscal years 2004-2009. The Bush administration insisted that the highway bill should be entirely funded with resources from the Highway Trust Fund. The 2005 transportation bill shattered all earmark records by containing 6,373 separate earmarks worth $24.2 billion.7

What sort of spending programs are contained in those earmarks? In the 2005 highway bill, one earmark worth $6 million dollars went toward graffiti elimination in New York, another sent $2.95 million to Alaska for a film about state roads, and nearly $4 million was earmarked for the National Packard Museum in Warren, Ohio, and the Henry Ford Museum in Dearborn, Michigan.8

As early as 1955, Senator Prescott Bush foresaw the current problems with the process of allocating transportation dollars: “Highway legislation scatters billions of politically-guided Federal dollars over the country as though they were shot from a blunderbuss. These widely scattered dollars will not build those roads having the greatest public interest.” 9 The more the linkage between road spending and gasoline taxes deteriorates, the less likely it is that the public will continue to support current levels of gasoline taxes.

Is It Time to Increase the Gasoline Tax? Considering the increase in world oil prices throughout most of 2005 and 2006, and considering that the irresponsible use of current gasoline tax revenue is reaching an alarming level, many motorists are uneasy about proposals to increase gasoline taxes. However, that fact has not stopped a handful of distinguished economists and others from calling for large gas tax increases in recent months.

N. Gregory Mankiw, Harvard professor and former Chairman of the Council of Economic Advisers, recently authored a piece for the Wall Street Journal outlining his reasons for imposing a “Pigouvian” gasoline tax on American motorists.10 Professor Mankiw is the founder of the Pigou Club, which is named after Arthur C. Pigou, a renowned English economist from the early 20th century. Pigouvian taxes are designed to correct what economists call “market failures” or “negative externalities” that impose spillover costs on society.

Mankiw describes the club as “an elite group of economists and pundits with the good sense to have publicly advocated higher Pigouvian taxes, such as gasoline taxes or carbon taxes.” Mankiw has advocated phasing in a $1 per gallon increase in Pigouvian gasoline taxes over a decade to correct for social costs created by gasoline consumption – specifically relating to national security, traffic congestion and pollution.

In theory, using Pigouvian taxes is efficient and straightforward, but in practice, the Pigouvian solution is anything but simple. One important problem often ignored by advocates of Pigouvian taxes is what is typically referred to as the “knowledge problem.”11 That is, if gas taxes should be raised purely to offset the social costs of gasoline consumption, how high are those social costs, how would policymakers attempt to quantify them on an ongoing basis, and how high of a tax would be necessary to compensate for them?

Clearly, the practical difficulty of compiling data and estimating social costs is not trivial. Pigouvian taxes place enormously high information burdens on policymakers. Policymakers looking for social cost estimates in the economic literature will find results that vary widely. For example, there is a wide range of external cost estimates for gas, oil and other methods of power generation. These figures are compiled from various studies throughout the 1980s and 1990s, and estimates range from very large external costs to trivially small effects.12

Additionally, what level of total social welfare loss would Americans experience if policymakers overestimate the costs of externalities and implement an excessive Pigouvian tax? Those hit hardest would be the lower-income Americans who are already disproportionately harmed by the regressive nature of gasoline taxes. On the other hand, what convinces proponents of Pigouvian taxes that $1 per gallon would be enough to solve the plethora of harms that “under-priced” gasoline is said to create?13

Cleaning the Air? Even if policymakers were able to solve the “knowledge problem” that plagues Pigouvian taxes, finding the optimal policy solution for environmental externalities from fossil fuels may require additional analysis. For instance, even if a government-appointed central actor could somehow ascertain the “correct” tax rate that internalizes negative externalities from pollution, gasoline is probably the incorrect base for that tax. If the objective is to internalize environmental costs from fossil fuels, why not focus on carbon emissions directly?

Ending Gridlock? The idea of applying a Pigouvian-style tax to relieve traffic congestion is also misguided from a public policy perspective. Gasoline usage is not the proximate cause of traffic congestion. Raising the gasoline tax to help ease traffic congestion would be dreadfully inefficient, since it would tax a driver on a country road outside of Dodge City, Kansas at the same rate as it would tax a driver during rush hour in Washington, D.C. Absent congestion-based pricing for road usage, Americans would still suffer high volumes of traffic during certain times on certain roads even if automobiles ran on water.

Improving National Security? In his final Pigouvian justification for increasing gasoline taxes, Mankiw argues that the gas tax is “an economic policy with positive spillovers to foreign affairs.” 14 A common argument in support of this contention is that we should increase the gas tax to promote our “energy independence” from high-risk foreign sources of oil. While well intentioned, this argument neglects the important fact that the world market for oil is fully fungible. History has proven that even energy independent countries are harmed by worldwide supply disruptions.

Conclusion Average gasoline prices exceeded $3 per gallon in the wake of hurricane Katrina and again reached the $3 per gallon level before recently falling to about $2. Did we see traffic congestion magically disappear by paying $1 more per gallon? Was America’s national security strengthened by paying those high gasoline prices? Of course not – so Professor Mankiw’s plan to raise gasoline taxes by $1 over a decade would almost certainly not accomplish his desired results.

Raising gasoline taxes for Pigouvian purposes advances a dangerous view of tax policy, where government attempts to use the tax code as a tool to centrally plan economic decisions. The fundamental purpose of taxes is to raise necessary revenue for government programs, not micromanage a complex market economy with subsidies and penalties. The tax system’s central aim should be to minimize distortions in the economy, and to interfere as little as possible with the decisions of free people in the marketplace.

If policymakers wish to salvage the reputation of gasoline taxes as the “best taxes,” they would be wise to reestablish the linkage of gasoline taxes with road spending and reject superfluous Pigouvian levies.

State Gasoline Tax Rates as of July 2018

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The Tax Foundation is the nation’s leading independent tax policy nonprofit. Since 1937, our principled research, insightful analysis, and engaged experts have informed smarter tax policy at the federal, state, and global levels. For over 80 years, our goal has remained the same: to improve lives through tax policies that lead to greater economic growth and opportunity.